Jamie Dimon, Chairman and CEO of JPMorgan Chase, Testifying Before Congress on the London Whale Trading Losses at His Bank

According to the Office of the Comptroller of the Currency (OCC), the regulator of national banks, as of December 31, 2018 JPMorgan Chase Bank NA (the Federally-insured bank backstopped by U.S. taxpayers) held $2,212,311,000,000 ($2.2 trillion) in equity derivatives. Equity is another name for stock. The OCC also reported that all commercial banks in the U.S. held a total of $3.374 trillion in equity derivatives at the end of last year, meaning that for some very strange reason, JPMorgan Chase holds a 65.5 percent market share of bank trading in this derivatives market.

Those trillion dollar figures are notional amounts, meaning the face value. The OCC defines “notional” like this: “The notional amount of a derivative contract is a reference amount that determines contractual payments, but it is generally not an amount at risk. The credit risk in a derivative contract is a function of a number of variables, such as whether counterparties exchange notional principal, the volatility of the underlying market factors…, the maturity and liquidity of the contract, and the creditworthiness of the counterparty.”

According to the OCC report, JPMorgan Chase lost $644 million on its equity positions in the fourth quarter of 2018. We don’t yet know what happened in the first quarter of this year because the OCC has not yet released its report.

Not only is JPMorgan Chase Bank NA engaging in risky stock derivative trades, but according to the OCC just 31 percent of these trades are centrally cleared. The other 69 percent are what are called over-the-counter or OTC derivative trades, meaning they are “bilateral,” or secret contracts between JPMorgan Chase and a counterparty with little daylight available to Federal regulators. That also would suggest that they are highly illiquid.

At this point, we should pause for a moment to explain what a “derivative” actually is. The OCC defines it this way: “A financial contract in which the value is derived from the performance of underlying market factors, such as interest rates, currency exchange rates, commodity, credit, and equity prices.”

Another definition of a derivative might be this: a type of trade where Wall Street mega banks, with far superior market knowledge from trillions of bits of internal trading data, can sell sh**t packaged as a solid investment to the dumb tourists who manage public pensions, municipal funds, and school district bond issuance, to name just a few. We apologize for the pejorative “dumb tourist,” but compared to the Ph.D. computer geeks, artificial intelligence software, and algorithmic trading that dominate Wall Street trading floors, we’re all dumb tourists. (See JPMorgan Employs 30,000 Programmers.)

Unfortunately, sometimes common sense escapes all of these financial wizards and cowboy instincts take over, putting those Federally-insured deposits at serious risk. That’s precisely what happened in 2012 when JPMorgan Chase Bank NA was caught trading exotic derivatives in London to the tune of hundreds of billions of dollars and ended up losing at least $6.2 billion of depositors’ money. That episode became infamously known as the London Whale scandal. It resulted in Jamie Dimon, CEO of JPMorgan Chase, being hauled before Congress and a formal investigation by the Senate Permanent Subcommittee on Investigations, which delivered a scathing 300-page report on the matter. On September 19, 2013 JPMorgan Chase agreed to settle the matter with the Federal Reserve, the OCC, the SEC and the U.K. Financial Conduct Authority for $920 million.

The OCC had this to say about the bank at the time of settlement:

“The credit derivatives trading activity constituted recklessly unsafe and unsound practices, was part of a pattern of misconduct… The Bank failed to ensure that significant information related to the credit derivatives trading strategy and deficiencies identified in risk management systems and controls was provided in a timely and appropriate manner to OCC examiners.”

Senator Carl Levin, who chaired the Senate Permanent Subcommittee on Investigations at the time, said JPMorgan Chase “piled on risk, hid losses, disregarded risk limits, manipulated risk models, dodged oversight, and misinformed the public.” (Is that really a bank you want involved in $2.2 trillion of stock derivatives, 69 percent of which are shrouded in darkness?)

In February 2016, Bruno Iksil, the trader at the center of the London Whale scandal, released a letter to the media stating that he had been “instructed repeatedly” by senior management in the Chief Investment Office (CIO) to execute the strategy. The head of the CIO at that time was a woman named Ina Drew, who resigned from the bank in the midst of the scandal in 2012.

“In Drew’s testimony before the U.S. Senate’s Permanent Subcommittee on Investigations on March 15, 2013, Drew told the hearing panel that beginning in 1999, she ‘oversaw the management of the Company’s core investment securities portfolio, the foreign-exchange hedging portfolio, the mortgage servicing rights (MSR) hedging book, and a series of other investment and hedging portfolios based in London, Hong Kong and other foreign cities.’

“Drew told the Senate Committee that the investment securities portfolio exceeded $500 billion during 2008 and 2009 and as of the first quarter of 2012 was $350 billion. But during the 13 years that Drew supervised massive amounts of securities trading, she had neither a securities license nor a principal’s license to supervise others who were trading securities.

“We asked numerous Wall Street regulators to explain how this is possible at today’s too-big-to-fail banks. One regulator who spoke on background only told us that Drew could not hold a securities license because she worked for the bank not its broker-dealer. Only employees of broker-dealers are allowed to hold securities licenses. But apparently, not having a securities license does not stop one from supervising a $500 billion portfolio of securities that are, most assuredly, traded by someone.”

The London Whale episode is noteworthy from another angle: JPMorgan Chase’s Chief Investment Office was also engaged in or planning to engage in large amounts of stock and/or stock derivatives trading. Unfortunately, for unexplained reasons, most of the stock trading information has been redacted from the Senate report. However, we were able to piece together clues as to what was going on. See Senate Censors Part of Report on JPMorgan About Its Stock Trading.

Now that Wall Street banks have a deregulatory regime in the White House, it is only natural to wonder if the cowboys are back in charge of trading at JPMorgan Chase. On that point, the OCC reports that at the height of the financial crisis in the fourth quarter of 2008, equity derivative contracts held by commercial banks totaled just $737 billion, or just 22 percent of the $3.374 trillion today, of which JPMorgan controls two-thirds.

Adding to the concerns of what’s going on at JPMorgan Chase, is the question as to why the bank isn’t using the multitude of exchange-traded products available to take positions in the stock market, like the popular and liquid futures contract on the Standard and Poor’s 500 index, and why it isn’t making the trades in its investment bank instead of its Federally-insured commercial bank.

The troublesome answer is likely contained in this article at Risk.net which names JPMorgan the “equity derivatives house of the year.” If you read the article to the end, it becomes clear that JPMorgan Chase is customizing (known as “bespoke” contracts) equity derivatives in large amounts and with highly complex terms.

Is this really what we want our nation’s largest Federally-insured commercial bank to be engaged in? All of the Federal regulators were caught sleeping over the London Whale losses. The extent of the losses only came to light as a result of reporting at the Wall Street Journal and Bloomberg News – which Jamie Dimon initially tried to brush away as a “tempest in a teapot.”

Tomorrow the House Financial Services Committee is holding a hearing titled: Oversight of Prudential Regulators: Ensuring the Safety, Soundness and Accountability of Megabanks and Other Depository Institutions. Let’s hope JPMorgan’s equity derivative trades see some daylight at this hearing.